Sunday, September 8, 2013

If
one reads the country’s pink press or listens to the ‘experts’ appearing on television regularly, one might wonder why, with so many brains around to solve the country's problems, the problems are still there and not going away. The answer
for this is not difficult to see. Given below are three common myths that surround the debate, making problem solving exercise an exercise in futility:

Myth # 1: GDP
growth is utopia

No
other economic statistic is probably as abused as “GDP growth”. Very few
understand what (GDP) ‘growth’ is, and even fewer the limitations of this number. That is
precisely why, probably, every politician worth his salt finds it a handy tool
to misuse. GDP, or Gross Domestic Product, is the sum total of all output of final goods and services produced in the
country in a given period. GDP growth then, is the increase in this output, adjusted for inflation. GDP growth shows
how much more the country has
produced compared to a previous period, usually the year. All this is fine.

However, it is rarely discussed that:

What
matters is not the absolute GDP growth but per
capita growth, especially when comparing GDP figures between two
different countries. For example, U.S. GDP grew by 2.78 % between 2011 and
2012, while India’s GDP grew at 4.99 %, faster than that of the U.S. However, India’s per capita GDP actually fell from $ 1,534
in 2011 to $ 1,489 in 2012 while U.S.’ per capita GDP grew from $ 48,113 to $
49,965. (Source: World Bank). Indians were thus worse off than they were the previous year. All talk about
India being “…one of the fastest growing economies in the world…” is thus
meaningless, because India's per capita figures almost invariably turn out to be much worse.

Then
there are other factors to be considered such as the composition of this
GDP growth. In India, government buys food grains every year at higher and
higher prices through an administrative fiat (MSP) with tax payer money which
then rots in government godowns. This production counts as GDP, but it never reaches the consumer. With
his remaining money, the tax payer ends up buying the remaining foodgrains in the open market at inflated
prices, because so much of legitimate supply has gone out of market.

In
a healthy economy, higher GDP figure should be supported by two other
characteristics – increase in productivity and increase in job creation.
India’s average GDP growth between 1999-00 to 2004-05 was 5.76 % and between
2004-05 and 2009-10 was 8.73 %. But the number of jobs created between 1999-00
to 2004-05 was 60.70 million whereas between 2004-05 to 2009-10 was just 2.72
million (Source: Planning Commission).

GDP
growth is thus just a statistic that needs to be taken with a fistful of salt.
GDP growth is an outcome of a healthy
economy, but it does not necessarily constitute proof of one.

Myth # 2: The
growth – inflation paradox

This
probably is the biggest myth of them all – that
the Central Banks are perpetually facing a Catch–22 situation: if rates are
reduced (or liquidity increased, which has the effect of lowering rates) to
propel growth, inflation flares up and if rates are raised (or liquidity tightened)
to control inflation, growth suffers.

Let’s
get this straight here – Bank lending and borrowing (i.e. deposit) rates move
in tandem. If you want lending rates to come down, deposit rates need to be
lowered too. And deposit rates cannot be delinked from inflation rate. Interest
is the time value of money. The way an economy grows is like this: interest rates get high enough to encourage savings; this encourages people to save more. The
banks (and others such as insurance & pension funds etc) become flush with
money. They then compete among themselves to lend, which brings down lending
rates. This in turn encourages more consumption and capital investment, promoting
growth.

Lower
interest rates are thus a result of increased availability of capital, which in
turn is a result of increased savings, which in turn is a result of higher income and low inflation! That’s how low interest rate induces growth. All the
economies which have shown high growth rates in the past, such as Singapore or
China or even India have done so on the back of a high savings rate. Countries
which tried to grow through excess leveraging, such as those in Europe or the
U.S. are facing problems today.

What
happens if inflation rate is higher than the rates of return savers get (the so-called
negative real interest rate)? If inflation
is high, disposable incomes fall; inducing people to cut down on discretionary consumption.
There is also a flight of capital to hard assets and speculative investments,
causing asset price bubbles.

Myth # 3: Central Banks can cure all economic ills

The
media pays too much attention to Central Bank actions. The Central Bank
can only do this much, and nothing more. It has the mandate to maintain the
value of the currency, to oversee (but not
to run) the banks and to run the credit & payment system in the country. The
fiscal policy, the trade policy, the industrial policy, the law and order, the availability
of manpower and requisite skill sets, the legal framework, the ease of doing
business – there are several factors that impact how the economy
performs. Most of these are under government influence. Most of the times,
governments make things worse, in the guise of ‘regulating’ them. You just
can’t expect the Central Bank to have a magic wand which will make all sins
of the government disappear and power the economy full throttle.

In
a 2012 World Bank ranking of 185 countries on “Ease of Doing Business", India ranked
132nd. The rankings rate countries on parameters such as starting a
business, dealing with construction permits and enforcing contracts. Here is the latest example - a bill introduced in Indian Parliament to “regulate” street vendors will soon make it impossible for anyone to even sell peanuts on the streets. And we expect Central Bank to promote
growth!

When
you bust these myths, most of what appears in the pink press or the business channels on how to promote growth will cease to make any
sense.